Wi-Lan: Positive Announcements Receive Negative Reaction
May. 29, 2014 7:16 AM ET
Jim Mullin
Value, dividend investing, medium-term horizon
Disclosure: I am long WILN, AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
Summary
In 2013, Wi-Lan announced it was embarking on a strategic review to determine the future of the company. Wi-Lan has made some major changes to its business in an effort to increase revenue, raise operating leverage, and return more money to shareholders. Despite many promising changes, the share price fell following the company's announcement. Overview
Following a disappointing 2013, Wi-Lan's ( WILN) Board of Directors embarked on a strategic alternatives review. With the setbacks that Wi-Lan was experiencing, its Board of Directors believed that alternatives should be examined. The plan was to look at any and all options, including a sale of the company, in an effort to maximize value for shareholders.
During the review period, Wi-Lan generated a good amount of positive news. In both Q4 2013 and Q1 2014, Wi-Lan had strong revenue and positive GAAP earnings. It expanded the breadth of its patent portfolio and signed many new licensing deals. The company also received good news in ongoing disputes with Apple ( AAPL).
On May 14th, the company announced the conclusion of its strategic review. The company plans to make significant changes that are expected to add value going forward. The market reaction was overwhelmingly negative. An overview of its announcement can be found here, and more details can be heard on its most recent conference call.
Announced Changes
Portfolio Transitions In a major departure, Wi-Lan has decided to change the way its customers license patents. The company will now license specific portions of its patent portfolio, as opposed to requiring customers pay for the entire portfolio. This change was inevitable given the expanding scope of Wi-Lan's portfolio. This makes sense for Wi-Lan, because its customers are presumably interested in paying only for patents they plan to use. Management believes this will drive revenue growth by increasing the number and frequency of license signings. Wi-Lan should be able to generate new business, as companies that were unwilling to pay for the entire portfolio may be interested in paying only for relevant portions. This change will also make it easier for Wi-Lan to divest unneeded patents. With customers paying only for specific patents, it will be readily apparent which patents add no value to the company. These patents can then be sold to reduce expenses.
In a related move, Wi-Lan has announced that it will be focusing on a small number of high-quality patents when adding to its portfolio in the future. The company is looking to take on only patents that have strong licensing potential. Since future licensing revenue will come from the specific patents that customers pay to use, it makes little sense for Wi-Lan to own patents that offer no value to its customers. A smaller portfolio will also help reduce Wi-Lan's maintenance costs, which will be discussed later. Through a combination of changes in licensing, a focus on quality, and divestitures, Wi-Lan hopes to be left with a smaller, but higher-quality portfolio.
Use of Partnerships In the past, Wi-Lan would purchase desirable patents and then license them to its customers. Recently, Wi-Lan has expanded its use of partnerships as an alternative to the outright purchase of patents. In its recent announcement, the company has confirmed that it is looking to focus on partnerships and that it plans to purchase fewer patents in the future. In its partnerships, Wi-Lan receives a percentage of the revenue it can generate from the patent, but the original patent holder maintains ownership. As an added bonus, these partnerships often do not require an upfront payment by Wi-Lan. Since fewer patents will be purchased, Wi-Lan should see an immediate reduction in its capital expenditures. Over time, as acquisitions decrease, the company should see a decline in its amortization expense. Amortization was Wi-Lan's largest expense over the past two quarters, so this could have a noticeable impact on net income down the line.
Reducing Expenses Legal expenses have been a thorn in Wi-Lan's side for years. Recently, the company has made progress in reducing these costs. The graph below shows the decrease in the amount of Wi-Lan's litigation expense over the past year. In the past two quarters, Wi-Lan began sharing risk with its legal counsel. Under this arrangement, Wi-Lan's lawyers receive a base payment, and are able to earn additional money following successful litigation or when licenses are signed. Management has stated that its legal counsel will make most of its money through these contingency fees. This new agreement is likely to reduce the amount of litigation that Wi-Lan pursues. Less litigation will obviously limit litigation expense. This risk-sharing deal ensures that the incentives of Wi-Lan's legal team are aligned with the best interests of company.
With each passing month, it would seem that the case against Wi-Lan has been weakening. Following its loss to Apple, the belief was that companies would no longer be willing to sign licensing agreements with Wi-Lan. As subsequent deals were signed, talk turned to how high legal expenses would prevent Wi-Lan from being profitable. Now that legal expenses are under control, the bear case revolves around Wi-Lan being unable to generate meaningful future revenue aside from what is already in its backlog. In its most recent conference call, management gave a fairly detailed projection of a significant amount of future revenue that is not currently in the backlog. Should this new revenue begin to materialize, it will be interesting to see the next argument against Wi-Lan.
Conclusion
I believe Wi-Lan is on the right track. It has identified changes that will lead to higher revenue, less risk, and more money in the pockets of shareholders. Management clearly outlined the ways in which it plans to increase revenue, while decreasing expenses over the coming years. Some signs of what is to come could be seen in Q1 2014, and it will be exciting to see the remainder of Wi-Lan's new strategy put into place in the coming months. Management's financial goals call for significant growth in both revenue and income over the next five years. Management has set the bar high, but its updated business plan should help it reach these targets. Despite the market's reaction, the conclusion of Wi-Lan's strategic review has strengthened my belief in the company.
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